own professional malpractice. In other words, each individual shareholder is liable for any damages resulting from his or her own professional negligence. For this reason, it is incumbent upon PAs who practice in any type of business entity, including professional corporations, to make sure they are adequately insured. Such insurance should cover both the entity and each individual practitioner. The second defining characteristic of a corporation, including a professional corporation, is that it has an indefinite life and its shares are freely transferable, subject to limitations under state law or any agreement between the shareholders limiting share ownership. In most states, shares in a professional corporation can only be sold or transferred to other “qualified persons,” which is typically defined as a practitioner who practices the profession for which the professional corporation was formed, or (in some states) a related profession. The shareholders of many professional corporations also enter into a “Shareholders’ Agreement” which further limits the circumstances under which any of the shareholders may transfer their shares to third parties. A Shareholders’ Agreement may also establish the price at which the corporation or other shareholders may purchase shares from a departing shareholder, e.g., upon retirement or termination. One of the potential disadvantages of a corporation is that its profits, if any, can be subject to “double taxation.” In other words, if the corporation has profit at the end of its tax year, that profit is taxable to the corporation. The profit is taxed a second time when it is distributed to its shareholders. This problem can be successfully addressed in either of two ways. First, if a corporation pays out all of its income in the form of reasonable compensation or pays other bona fide expenses prior to the end of the tax year, it will have no taxable profit. Secondly, a corporation can make an “S” election. By electing to be treated as a “Subchapter S” corporation, it is treated by the IRS as a “flow through” entity, which means that any profit at the end of the tax year is treated as having been received directly by the shareholders, thereby avoiding taxation at the corporation level. There may, however, be other consequences of making an “S” election which may depend on the individual circumstances of the parties. Therefore, whether to make an “S” election should be discussed with the practice’s accountant or attorney. Professional Limited Liability Companies. Professional limited liability companies are a relatively new type of entity that are increasingly used as a vehicle for ownership of a professional practice. A professional limited liability company is, in effect, a hybrid between a corporation and a partnership (discussed below). The owners of a professional limited liability company, who are known as “members,” enjoy limited liability from the professional limited liability company’s business liabilities to the same extent as shareholders in a professional corporation. In addition, a professional limited liability company is treated under tax law similar to a partnership or a Subchapter S corporation, i.e., it is a “flow through” entity, thereby avoiding double taxation. Most states permit a professional limited liability company to be owned by a single member, but there are a few states where they must be owned by at least two members. Because professional limited liability companies are a relatively new form of professional entity, it remains more common to own a professional practice through a professional corporation. However, the relative tax and other advantages and disadvantages of the two types of entities should be discussed with the practice’s legal counsel or accountant to
4 DLMR_628211.1